EXECUTIVE SUMMARY

This paper provides the basis for the quinquennial review of the method of valuation of the Special Drawing Right (SDR). The review considers the composition, size, and weighting of the SDR currency basket and the financial instruments used to determine the SDR interest rate.  

The analysis in this paper is guided by the informal discussion of Executive Directors in July on initial considerations for the review. In light of Directors’ preference, the two currency selection criteria for SDR inclusion are maintained. Since China continues to meet the export criterion, a key focus of this paper is on assessing whether the renminbi (RMB) could be determined to be a freely usable currency, which is the second criterion.

The paper documents the rising international use and trading of the RMB since the 2010 SDR valuation review. A range of indicators suggests that use of the RMB in international transactions has risen substantially, albeit from a low base. The paper also finds that the RMB has become far more actively traded in foreign exchange markets, with sufficient depth to support operations of the size Fund members might undertake without an appreciable change in the exchange rate.

The Chinese authorities have taken a broad set of measures to further facilitate RMB operations by the Fund and the membership, covering all areas identified by staff in July. These steps include the liberalization of access to the onshore fixed-income and foreign exchange markets for Fund members and agents acting on their behalf. Recent volatility in onshore and offshore markets has highlighted some operational challenges, but the resulting impact on members is mitigated by their ability to use whichever of these markets is most advantageous.  

Staff proposes that the Executive Board determine the RMB to be a freely usable currency, and include it in the SDR basket. While the legal framework sets forth the criteria that must be satisfied for a currency to be determined freely usable, the application of these criteria in assessing specific currencies ultimately requires the exercise of policy judgment. In the judgment of staff, the RMB can be considered to be both widely used and widely traded within the meaning of the definition of a freely usable currency set forth in the Articles of Agreement. RMB markets are also sufficiently developed to provide market-determined exchange rates, a benchmark interest rate, and hedging instruments that meet the operational needs of the Fund, members, and other SDR users. While recognizing some operational challenges, staff is satisfied that these are manageable.  

Staff proposes to expand the SDR basket to five currencies. Keeping the current four currencies (British pound, euro, Japanese yen, and U.S. dollar) and adding the RMB would preserve stability in the composition of the basket while increasing its representativeness of the currencies used in the global trade and financial system. The added complexity of moving to a five-currency basket is expected to be limited and manageable for the Fund, members, and other SDR users.

For the purpose of assessing the export selection criterion and currency weighting, staff proposes to extend to all currencies the currency-based approach applied to monetary unions. This proposal recognizes, given the purpose of the SDR (which is not synonymous with the purpose of the “freely usable currency” concept), that the economic variables used for currency selection (other than the freely usable criterion) and currency weighting should reflect the characteristics of currencies rather than members.  

Staff also proposes to adjust the formula for determining the weights of the SDR basket currencies. The proposed weighting formula would address long-recognized shortcomings of the current formula, providing equal weights for trade and financial indicators, with the latter incorporating a broader range of financial variables.

Staff proposes to include the three-month benchmark yield for China Treasury bonds as the RMB-denominated interest rate instrument in the SDR interest rate basket. For the other currencies comprising the SDR basket, the instruments used to determine the SDR interest rate would continue to be based on the yields on three-month government securities.  

Staff proposes October 1, 2016 for the effectiveness of the new SDR basket and the RMB as a freely usable currency. In August 2015, the Board already approved an extension of the current SDR basket through September 30, 2016. Setting a future date for the effectiveness of the freely usable decision will help provide sufficient lead time for the Fund, members, and other SDR users to adjust to these changes.  

Finally, staff proposes that the SDR basket be established for five years, consistent with past practice. Accordingly, and following the Executive Board’s earlier extension of the current SDR basket through September 2016, the next review of the method of valuation of the SDR would take place by September 30, 2021, unless developments in the interim justify an earlier review.